ORY  OF 
NO  CREDIT 


THE  LIBRARY 

OF 

THE  UNIVERSITY 
OF  CALIFORNIA 


HENRY  RAND  HATFIELD 
MEMORIAL  COLLECTION 

PRESENTED  BY 

FRIENDS  IN  THE  ACCOUNTING 
PROFESSION 


THE  THEORY  OF 

DEBIT  AND  CREDIT 

IN  ACCOUNTING 


by 
Robert  Gardner  McClung 


Boston 

Morgan,  Mills  and  Company 
1913 


Copyright,  1913,  by 
Kobert  Gardner  McClung 

All  Eights  Reserved 
for  all  countries 


Published  November  1913 


PREFACE 

Every  student  of  accounting  experiences 
difficulty  in  seeing  any  principle  on  which  im- 
personal accounts  are  debited  and  credited. 
At  the  outset,  he  wonders  why  "Cash" 
should  be  debited  when  money  is  received, 
and  credited  when  money  is  paid  out;  and, 
as  the  other  impersonal  accounts  are  taken 
up,  his  difficulty  increases.  Various  ex- 
planations for  the  debit  and  credit  of  im- 
personal accounts  have  been  given.  None 
of  them  ever  seemed  to  the  writer  satisfac- 
tory. After  long  and  careful  consideration 
of  the  subject,  he  submits  the  explanation 
contained  in  the  following  pages  as  the  cor- 
rect one. 

R.  G.  M. 

Boston,  Aug.  6,  1913. 


M513286 


THE   THEORY   OF   DEBIT   AND 

CREDIT  IN  ACCOUNTING 
THERE  cannot  be  a  debtor  unless  there  is  a 
creditor,  and  there  cannot  be  a  creditor  un- 
less there  is  a  debtor.  The  terms  are  cor- 
relative; the  one  implies  the  other.  An  im- 
personal thing  cannot  be  either  a  debtor  or 
a  creditor,  except  by  a  fiction.  A  thing, 
however,  may  stand  for  a  person  who  is  a 
debtor  or  a  creditor.  In  other  words,  it 
may  represent  him. 

A.  deposits  one  thousand  dollars  with  me. 
He  is  a  creditor;  I  am  a  debtor.  I  open  an 
account  in  his  name  and  credit  him  one 
thousand  dollars.  To  complete  the  record, 
I  might  open  an  account  in  my  name  and 
debit  this  account  one  thousand  dollars.  On 
my  books,  however,  there  is  no  object  in 
opening  the  second  account.*  If  A.  is  cred- 
ited on  my  books,  the  implication  is  that  I 
am  the  debtor.  The  second  account  would 
give  me  no  additional  information .  If  money 
were  the  only  thing  by  reason  of  which  A. 
could  be  credited,  and  with  which  I  could  be 
charged,  there  would  never  be  any  object  in 
opening  the  second  account.* 

*  Except  to  put  the  books  in  balance. 


Instead,  however,  of  depositing  one  thou- 
sand dollars  with  me,  A.  might  have  deliv- 
ered to  me,  for  safe  keeping,  a  valuable 
picture,  worth  one  thousand  dollars.  Or, 
again,  he  may  deposit  with  me  one  thou- 
sand dollars  in  money,  and  may  also  de- 
liver to  me,  for  safe  keeping,  a  picture 
worth  one  thousand  dollars.  Where  I  may 
be  charged  with  different  things,  there  is  an 
advantage  in  showing  on  my  records  with 
what  I  am  charged.  Therefore,  after  open- 
ing an  account  in  the  name  of  A.,  and  cred- 
iting him  one  thousand  dollars  on  account  of 
the  money,  and  one  thousand  dollars  on  ac- 
count of  the  value  of  the  picture,  I  open  two 
additional  accounts.  One  might  be  in  my 
name  with  the  additional  statement  that  it 
was  in  the  matter  of  (or  related  to)  money. 
The  other  might  be  in  my  name  with  the 
additional  statement  that  it  was  in  the  mat- 
ter of  the  picture.  It  is  unnecessary,  how- 
ever, to  mention  my  name.  It  is  sufficient, 
if  I  call  the  one  account  "Cash,"  and  the 
other  account  "  Picture."  In  the  one  case 
it  is  understood  that  the  account  stands  for 
me  in  the  matter  of  cash;  in  the  other  case 
it  is  understood  that  the  account  stands  for 
me  in  the  matter  of  the  picture.  The  cash 


account  represents  me,  and  the  picture  ac- 
count represents  me.  The  cash  account  I 
debit  one  thousand  dollars,  meaning  that  I 
am  debited  in  the  matter  of  cash.  The  pic- 
ture account  I  debit  one  thousand  dollars, 
meaning  that  I  am  debited  in  the  matter  of 
the  picture. 

A.  owes  B.  five  hundred  dollars,  and  asks 
me  to  pay  B.  the  five  hundred  dollars  from 
the  one  thousand  dollars  that  I  hold  for 
him,  A.  I  therefore  pay  B.  the  five  hun- 
dred dollars.  As  to  this  five  hundred  dol- 
lars, A.,  of  course,  is  no  longer  my  creditor. 
To  show  this,  I  enter  five  hundred  dollars 
on  the  debit  side  of  his  account.  This  off- 
sets his  credit  to  that  extent;  or,  to  express 
it  differently,  and  to  give  a  new  use  to  an 
old  word,  he  is  discredited  to  that  extent. 
I  wish  to  show  on  my  records,  also,  that  I 
am  no  longer  charged  with  the  five  hun- 
dred dollars  which  I  have  paid  by  A.  's  direc- 
tion to  B.,  and  therefore  I  credit  the  account 
called  "Cash,"  which  represents  me,  five 
hundred  dollars.  This  credit  shows  on  my 
records  that  I  am  discharged,  in  the  matter 
of  cash,  to  the  extent  of  the  payment. 

Again,  suppose  A.  wishes  to  convert  his 
picture  into  money,  and  requests  me  to  sell 


the  picture  for  him.  I  sell  the  picture  to  C. 
for  one  thousand  dollars.  C.  pays  me  the 
money,  and  I  deliver  to  C.  the  picture.  No 
longer  am  I  charged  with  the  picture.  The 
account  called  "  Picture"  I  therefore  credit 
one  thousand  dollars,  the  sum  for  which  I 
sold  it.  I  am,  however,  responsible  to  A.  for 
the  one  thousand  dollars  which  I  have  re- 
ceived for  the  picture.  Therefore  I  charge 
myself  with  this  money,  in  the  account 
called  "Cash."  The  nature  of  my  respon- 
sibility has  changed.  Whereas  I  was  pre- 
viously charged  with  a  picture  at  its  value 
of  one  thousand  dollars,  now  I  am  charged 
with  the  cash  for  which  it  was  sold.  A.  has 
been  already  credited  with  the  value  of  the 
picture,  and  therefore  it  is  not  necessary  to 
credit  his  account  again.  A.  's  account  shows 
a  credit  of  fifteen  hundred  dollars,  and  the 
cash  account  shows  a  debit  of  fifteen  hun- 
dred dollars. 

A.  wishes  the  money.  Therefore  I  pay 
the  fifteen  hundred  dollars  to  A. ,  and  debit 
his  account,  and  credit  the  cash  account, 
which  represents  me;  and  the  transaction 
is  closed. 

In  the  above  discussion  the  words 
"  debtor  "  and  "  creditor  "  are  used  in  their 


accounting  sense.  In  accounting,  the  terms 
"  deb  tor"  and  "  creditor"  may  express  the 
legal  relation  of  agent  and  principal,  as  well 
as  the  legal  relation  of  debtor  and  creditor. 
From  a  legal  point  of  view,  it  is  possible,  in 
the  above  money  transactions,  to  regard  A. 
as  a  principal  and  me  as  an  agent,  or  A.  as  a 
creditor  and  me  as  a  debtor.  In  both  events, 
however,  my  accounts  would  be  kept  in  the 
same  way;  except  that,  if  the  relation  be- 
tween A.  and  me  is  that  of  principal  and 
agent,  there  might  be  a  statement  to  that 
effect.  Both  in  the  matter  of  the  money 
and  in  the  matter  of  the  picture,  we  will 
regard  the  legal  relation  as  that  of  principal 
and  agent. 

Again,  suppose  E.  delivers  to  me  as  his 
agent  a  thousand  dollars,  and  authorizes  me 
to  borrow,  on  his  behalf,  a  like  sum  of  a 
third  person.  On  my  books,  I,  in  the  name 
of  "Cash,"  am  debited  a  thousand  dollars, 
and  E.  is  credited  a  thousand  dollars.  In 
the  exercise  of  my  authority,  and  on  behalf 
of  E.,  I  borrow  a  thousand  dollars  of  F.  On 
account  of  this  second  transaction,  I,  in  the 
name  of  U0ash,"  am  debited  a  thousand 
dollars,  and  F.  is  credited  a  thousand  dol- 
lars. The  accounts  that  I  have  kept  as  agent 


now  show  that  I  am  debited  two  thousand 
dollars;  that  E.,  my  principal,  is  credited  a 
thousand  dollars;  and  that  F.,  a  legal  credi- 
tor, is  credited  a  thousand  dollars. 

In  all  double-entry  accounting,  the  ac- 
counts are  kept  as  if  there  were  a  principal 
and  an  agent;  although,  at  the  same  time, 
there,  also,  may  be,  with  a  third  person,  a 
relation  of  debtor  and  creditor.  The  prin- 
cipal is  sometimes  called  the  proprietor,  and 
the  agent  the  manager;  and  in  mercantile 
transactions  this  is  the  common  nomencla- 
ture. 

The  cash  account  and  the  picture  account, 
in  the  above  examples,  are  but  illustrations 
of  a  large  group  of  accounts  called  "  prop- 
erty accounts  "  (or  "  real  accounts  ").  Each 
of  these  property  accounts,  in  theory  at  least, 
stands  for  a  person,  who  acts  as  an  agent, 
and  is  responsible  to  a  principal  for  the  prop- 
erty described  in  the  name  of  the  account. 
These  accounts  might  be  called  agency  or 
managership  accounts. 

There  is  no  difference  in  theory  between 
the  cash  account  and  other  property  ac- 
counts; except  that  cash,  being  a  standard 
of  value,  is  valued  in  terms  of  itself,  while 
other  property  is  valued,  not  in  terms  of 


itself,  but  of  cash.  This  difference  in  meth- 
ods of  valuation,  however,  does  not  affect 
the  principle  of  debit  and  credit.  Cash  be- 
ing also  a  medium  of  exchange,  the  cash 
account  is  put  to  certain  uses  that  other 
property  accounts  are  not. 

A  different  class  of  accounts  represents, 
not  the  agent,  but  the  principal  (or  propri- 
etor). In  this  class  are  the  accounts  called 
"  Capital"  and  "  Surplus;"  the  various 
" reserve  accounts;"  the  account  called 
"Profit  and  Loss;"  and  the  various  sub- 
sidiary profit  and  loss  accounts  —  such  as 
the  "  rent  account,"  the  "  salary  account," 
the  miscellaneous  expense  account  com- 
monly called  "  Expense,"  the  "services  ac- 
count," and  the  account  (under  whatever 
name)  recording  the  differences  between 
the  prices  at  which  goods  are  bought  and 
the  prices  at  which  they  are  sold.  By  some 
writers  on  the  subject,  who  have  seen  the 
true  nature  of  the  accounts  in  this  class, 
they  are  called  "proprietorship  accounts." 
Any  item  charged  or  credited  to  any  one  of 
the  accounts  in  this  class  could  have  been 
charged  or  credited  directly  to  the  proprie- 
tor under  his  own  name.  The  subsidiary 
profit  and  loss  accounts  may,  at  first  glance, 


seem  far  removed  from  the  proprietor;  but 
the  items  charged  or  credited  to  these  ac- 
counts might  just  as  well,  as  far  as  the  the- 
ory of  accounting  is  concerned,  be  charged 
or  credited  directly  to  the  proprietor.  They 
are  charged  or  credited,  in  the  first  place, 
to  special  accounts  bearing  impersonal 
names,  simply  to  show,  by  means  of  classi- 
fication, the  sources  of  losses  and  gains.  In 
so  far  as  the  debits  exceed  the  credits,  these 
accounts  show  sources  of  loss  to  the  propri- 
etor, and,  in  so  far  as  the  credits  exceed 
the  debits,  they  show  sources  of  gain  to  the 
proprietor;  but,  whether  they  show  losses 
or  gains,  the  accounts  represent  the  propri- 
etor.* 

Still  a  third  class  of  accounts  represents, 
not  the  agent  (or  manager),  nor  the  princi- 
pal (or  proprietor),  but  third  persons.  The 
important  account  in  this  class  is  < '  Bills 
Payable."  I  buy  one  thousand  bushels  of 
wheat  of  M.  at  one  dollar  a  bushel.  I  can 
pay  M.  one  thousand  dollars  in  cash;  but, 

*  The  term  "  nominal  accounts  "  is  frequently  ap- 
plied to  the  subsidiary  profit  and  loss  accounts ;  but, 
if  the  term  is  used  at  all,  it  might  be  well  to  extend 
its  use  to  all  proprietorship  accounts  that  do  not  bear 
the  name  of  the  proprietor. 

8 


if  it  is  not  convenient  for  me  at  the  time  to 
pay  him  cash,  and  he  is  willing  to  extend 
credit  to  me  for,  say,  thirty  days,  I  open 
an  account  in  his  name  on  my  books,  and 
credit  him  one  thousand  dollars.  It  may 
be,  however,  that,  although  M.  does  not  in- 
sist upon  my  paying  him  the  money  at  the 
time  of  the  transaction,  he  would  like  my 
obligation  to  pay  him  one  thousand  dollars 
to  be  in  a  more  tangible  form.  Therefore 
I  give  him  a  note,  in  which  I  promise  to 
pay  him,  or  his  order,  one  thousand  dollars 
thirty  days  after  date.  In  this  event,  I  do 
not  credit  M.  on  my  books,  but  I  open  an 
account  called  '  <  Bills  Payable, "  and  I  credit 
this  account  one  thousand  dollars.  This 
account  represents  M. 

A  fourth  class  of  accounts  may  be  re- 
garded as  representing  either  the  agent  or 
a  third  person,  but  primarily  represents 
the  third  person.  The  important  account 
in  this  class  is  "  Bills  Keceivable."  I  sell 
five  hundred  bushels  of  the  wheat  I  bought 
from  M.  to  N.  at  one  dollar  and  twenty 
cents  a  bushel,  and  N.  gives  me  his  note, 
in  which  he  promises  to  pay  me,  or  my 
order,  six  hundred  dollars  thirty  days  after 
date.  In  this  event,  I  do  not  open  an 


9 


account  in  the  name  of  N.  and  debit  it,  but 
I  open  an  account  called  "  Bills  Receiva- 
ble," and  I  debit  this  account.  This  ac- 
count, called  "  Bills  Receivable,"  represents 
N.  But  this  account  may  also  be  regarded 
as  representing  the  agent,  because  a  bill  re- 
ceivable may  be  regarded  as  property.  A 
bill  receivable  may  be  regarded  as  property 
either  on  account  of  its  material  character 
or  because,  in  a  sense,  any  debt,  due  from 
one  person  to  another,  is  property  of  the 
person  to  whom  it  is  due. 

On  the  "  Assets  "  (or  debit)  side  of  a  bal- 
ance sheet,  sometimes  appears  an  item  de- 
scribed as  ' '  Discount  on  Bonds "  (to  be 
written  off  gradually).  The  amount  of 
this  item  has  been  charged  to  a  discount 
account,  but,  instead  of  being  carried,  at 
the  end  of  the  year  (or  other  period),  at 
once  to  the  debit  of  "  Profit  and  Loss,"  or 
directly  to  the  debit  of  the  proprietor,  it  is 
maintained  on  the  books  as  a  separate  item, 
and  placed  in  the  balance  sheet.  This  item, 
of  course,  represents  the  proprietor. 

On  the  "  Liabilities  "  (or  credit)  side  of  a 
balance  sheet,  is  sometimes  found  an  item 
described  as  "  Accrued  Depreciation."  This 
item  has  been  taken  from  a  negative  prop- 


10 


erty  account,  also  called  "  Accrued  Depre- 
ciation," which  account  is^  in  theory,  only 
the  credit  side  (in  whole  or  in  part)  of  a 
positive  (or  ordinary)  property  account. 
Instead  of  being  credited  to  the  negative 
property  account,  called  "  Accrued  Depre- 
ciation, "  this  item  might  have  been  credited 
directly  to  the  positive  property  account. 
This  item,  of  course,  represents  the  mana- 
ger. Depreciation,  however,  affects,  not 
only  the  manager,  but  also  the  proprietor. 
At  the  same  time  that  an  account  repre- 
senting the  manager  is  credited  on  account 
of  the  depreciation,  an  account  represent- 
ing the  proprietor  is  debited  on  account  of 
the  same  depreciation.  The  account  rep- 
resenting the  proprietor  may  be  called 
"Profit  and  Loss,"  or  "  Depreciation, "  or 
any  one  of  a  large  number  of  other  names.* 

*  The  item  called  in  the  text  "  Accrued  Deprecia- 
tion "  (as  well  as  the  account  from  which  it  is  taken) 
is  usually  called  "  Reserve  for  Accrued  Depreciation  " 
or  ''Reserve  for  Depreciation;"  but  an  allowance 
for  accrued  depreciation  (except  so  far  as  the  allow- 
ance is  excessive)  is  not  a  true  reserve.  A  true  re- 
serve represents  the  proprietor,  while  an  allowance  for 
accrued  depreciation  (in  so  far  as  it  is  a  credit)  rep- 
resents the  manager.  This  item  (and  the  account 


11 


One  class  of  transactions  requires  an  ex- 
planation; and  that  is,  transactions  with 
third  persons.  One  thousand  dollars  is  bor- 
rowed from  a  third  person,  whom  we  will 
call  X.  X.  is  credited  one  thousand  dollars, 
and  "Cash"  is  debited  one  thousand  dol- 
lars. Strictly,  X.  should  be  credited  one 
thousand  dollars  in  his  relation  to  the  pro- 
prietor, and  the  proprietor  should  be  debited 
one  thousand  dollars  in  his  relation  to  X. ; 
and  then  the  proprietor  should  be  credited 
one  thousand  dollars  in  his  relation  to  the 
manager,  and  the  manager,  who  is  repre- 
sented by  < '  Cash, "  should  be  debited  one 
thousand  dollars  in  his  relation  to  the  pro- 
prietor. In  order  to  record  this  double 
transaction,  it  would  be  necessary  to  have 
two  accounts  in  the  name  of  the  proprietor 

from  which  it  is  taken)  might  properly  be  called  "  Al- 
lowance for  Accrued  Depreciation  "  or  "  Allowance 
for  Depreciation  "  or  simply  "  Depreciation."  How- 
ever, if,  instead  of  charging  the  depreciation  directly 
to  "  Profit  and  Loss,"  a  subsidiary  profit  and  loss 
account  should  be  opened  and  charged  with  the  depre- 
ciation, this  subsidiary  profit  and  loss  account  would 
naturally  be  called  "  Depreciation ;  "  and,  of  course, 
it  would  not  do  to  have  two  accounts  each  called 
"  Depreciation." 


12 


—  one  showing  his  relation  to  X.  and  the 
other  his  relation  to  the  manager.  But,  by 
a  fiction  of  accounting,  there  is  a  novation; 
X.  accepts  the  obligation  of  the  manager, 
represented  by  "Cash,"  and  releases  the 
proprietor,  and,  in  consideration  of  the  as- 
sumption by  the  manager  of  the  obligation 
to  X.,  the  proprietor  releases  the  manager. 
Of  course,  there  is  no  such  transaction, 
either  in  fact  or  in  law;  but  accounting 
seeks  to  accomplish  results  with  the  least 
expenditure  of  time  and  energy,  the  pro- 
prietor's credit  would  be  equal  to  his  debit, 
and  the  fictional  novation  satisfies  the  prac- 
tical requirements  of  the  situation. 

Again,  a  thousand  dollars  is  lent  to  a 
third  person,  whom  we  will  call  Y.  ' '  Cash  " 
is  credited  a  thousand  dollars,  and  Y.  is  deb- 
ited a  thousand  dollars.  Strictly,  in  this 
case,  the  manager,  who  is  represented  by 
"  Cash,"  should  be  credited  a  thousand  dol- 
lars in  his  relation  to  the  proprietor,  and 
the  proprietor  should  be  debited  a  thousand 
dollars  in  his  relation  to  the  manager;  and 
then  the  proprietor  should  be  credited  a 
thousand  dollars  in  his  relation  to  Y.,  and 
Y.  should  be  debited  a  thousand  dollars  in 
his  relation  to  the  proprietor.  But,  in  this 


13 


case  also,  there  is  a  fictional  novation;  the 
manager  accepts  the  obligation  of  Y.,  and 
releases  the  proprietor,  and,  in  considera- 
tion of  the  assumption  by  Y.  of  the  obli- 
gation to  the  manager,  the  proprietor  re- 
leases Y. 

Whether  the  system  of  accounting  is 
double-entry  or  not,  the  accounts  are  deb- 
ited and  credited  in  the  same  manner  as  if 
it  were. 

There  are  many  impersonal  accounts 
which  I  have  not  mentioned;  but  each  one 
of  them  represents  a  person  —  the  proprie- 
tor, the  manager,  or  some  third  person. 
The  so-called  impersonal  accounts  are  deb- 
ited or  credited  because  they  represent 
persons. 


14 


INDEX 
Accounting,  system  of,  does  not  affect 

principle  of  debit  and  credit,  14 
Agent,  5,  6 

Bills  payable  account,  8-9 
Bills  receivable  account,  9-10 

Capital  account,  7 
"Cash,  "2 
Cash  account,  6-7 
Creditor,  1,  4-5 

Debtor,  1,  4-5 

Debts,  are  property,  10 

Depreciation  account,  10-11,  ll-12n. 

"  Discount  on  Bonds,"  10 

Discredit,  3 

Double-entry  accounting,  6 

Expense  account,  7 

Impersonal  accounts,  debit  and  credit 

of,  14 
Impersonal  thing,  cannot  be  debtor  or 

creditor,  1 

Manager,  6 
Managership  accounts,  6 

Nominal  accounts,  8  n. 
Novation,  fictional,  13,  14 


15 


"Picture,"  2 

Principal,  5,  6 

Profit  and  loss  account,  7 

Profit  and  loss  accounts,  subsidiary,  7,  8  n. 

Property  accounts,  6 

Proprietor,  6 

Proprietorship  accounts,  7 

Real  accounts,  6 

Rent  account,  7 

Representation,  1,  14 

Reserve  accounts,  7 

Responsibility,  change  in  nature  of,  4 

Salary  account,  7 
Services  account,  7 
Surplus  account,  7 

Third  persons 

Accounts  representing,  8,  9 
Transactions  with,  12-14 


16 


s  ? 


sr 


YB  68802 


M513286 


